Sharp v. Commissioner , 42 B.T.A. 336 ( 1940 )

H. CECIL AND RUTH CARROLL SHARP, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Sharp v. Commissioner

Docket Nos. 97425, 97426.

United States Board of Tax Appeals

42 B.T.A. 336; 1940 BTA LEXIS 1013;

July 12, 1940, Promulgated

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1. The income of a trust, created by petitioner and her divorced husband, and payable to petitioner for the support of their minor child, is not taxable to petitioner, because the trust did not discharge any legal obligation of petitioner to support the child.

2. Where a French decree of divorce does not provide for the support of a child, the obligations of the husband to the child are not governed by French law and survive or terminate according to the laws of either the child's or the father's domicile.

3. Where the trustees of an irrevocable trust are vested with the discretion to determine which of the receipts of the trust are capital and which are income, capital gains of the trust, although not distributed as income, are taxable to the grantor under section 167(a)(2) of the Revenue Acts of 1934 and 1936, because the power to distribute such gains to the grantor is vested in the holder of a nonadverse interest.

Brooks Potter, Esq., and John Dane, Jr., Esq., for the petitioners.

Charles P. Reilly, Esq., for the respondent.

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LEECH

These consolidated proceedings are brought to redetermine deficiencies in income tax for the calendar years 1934, 1935, and 1936 in the respective amounts of $6,297.40, $1,476.61, and $1,477.35. With respect to the year 1936, petitioners also ask a finding of overpayment. The first issue is whether petitioner Ruth Carroll Sharp is taxable on the income of a trust which, according to the terms of the trust instrument, is to be paid to her for the support of her minor child. The second issue is whether the same petitioner is taxable on the capital gains of a trust created by her.

FINDINGS OF FACT.

Petitioners are husband and wife, and in the taxable years they filed joint returns. Since these proceedings involve only the tax liabilities of the wife, Ruth Carroll Sharp, she is hereinafter referred to as "petitioner."

On August 28, 1919, petitioner married Eben Sumner Draper, a resident of Massachusetts. Thereafter and until about January 1, 1926, they lived together and had their legal domicile in Massachusetts. Nancy Carroll Draper, the only issue of this marriage, was born on August 28, 1922, and was unmarried at the date of the commencement of these proceedings.

Early in 1926, petitioner and Draper were contemplating divorce. After extensive negotiations it was agreed that petitioner was to have custody of her daughter, except that the daughter was to spend three months of the year with Draper. He agreed to create the Nancy Carroll Draper trust and to convey to the trustees thereof securities having a market value of $200,000, and petitioner agreed to convey to the trustees securities having a market value of $100,000. Petitioner also agreed to create the Ruth Carroll Draper trust and to convey to the trustees thereof securities having a market value of $600,000. All the securities which petitioner agreed to contribute to these two trusts had been given to her by Draper at the time of their marriage, upon the understanding that the securities would be used by petitioner for the general benefit of the family.

In January 1926 petitioner went to France, where she established a domicile for the purpose of securing a divorce. Draper went to France for the same purpose. On July 8, 1926, petitioner and Draper were divorced in Paris, France. The decree awarded the custody of Nancy Carroll Draper to petitioner, but did not determine the property rights of the parties or the obligations to support Nancy Carroll Draper. These matters were left for negotiation by the parties, but the French court appointed a proper officer to settle such matters in the event the parties were unable to do so. Under the laws of France the divorce decree became final on September 27, 1926.

After the divorce petitioner and her daughter never returned to Massachusetts for the purpose of establishing a residence in that state. In December 1926 she and her daughter returned to the United States and took up their residence in the State of New York. From that time until her remarriage, petitioner had her domicile in New York. Upon the completion of the divorce proceedings Draper returned to Massachusetts and has lived there ever since. Draper is a man of substantial means and is now and has at all times been able to support, maintain, and educate Nancy Carroll Draper. At the time of her marriage to Draper, petitioner had no substantial means of her own.

H. Cecil Sharp married petitioner on March 23, 1929 in New York, New York. Prior to his marriage, Sharp had been a resident of New York. Subsequent to their marriage, petitioners and Nancy Carroll Draper continued to maintain their domicile in New York to and during the years 1934, 1935, and 1936. During those years, petitioner as a resident of New York paid income taxes to the State of New York, and also paid income taxes to the State of New York as guardian of her daughter, Nancy Carroll Draper. She was appointed as guardian on July 28, 1930, by the Surrogate's Court of New York County.

On November 1, 1926, in carrying out their stated agreement, petitioner and Draper transferred property in trust to Bentley W. Warren and John L. Hall, trustees. The trust was known as the Nancy Carroll Draper trust, and one-third of its corpus was contributed by petitioner and two-thirds by Draper. This trust since its creation has been held and administered in Massachusetts. The beneficiary was Nancy Carroll Draper, daughter of petitioner and Draper. For her care, maintenance, and education the trustees were to pay petitioner three-fourths of the net income and Draper one-fourth of the net income. Any excess income was to be added to principal. When the beneficiary reached the age of 21, the net income of the trust was to be paid to her for life, and upon her death the principal and accrued income were to be paid to her surviving issueper stirpes. In default of living issue of Nancy Carroll Draper, the corpus was payable to Draper or as he should have appointed by will or to his estate. The trust was revocable by joint action of petitioner and Draper, and, if so revoked, Draper would receive two-thirds and petitioner one-third of the corpus.

During 1934, 1935, and 1936 all the income of the Nancy Carroll Draper trust which was paid to petitioner was expended by her for the care, maintenance, and education of Nancy Carroll Draper in accordance with the terms of the trust instrument, and no part of such income was used by petitioner for her own individual purposes. Draper directed that his one-fourth share of trust income for those years be added to principal, and this was done.

On November 1, 1926, also in furtherance of the stated agreement, petitioner transferred certain personal property in trust to Bentley W. Warren and John L. Hall, trustees. This trust was known as the Ruth Carroll Draper trust, and since its creation has been held and administered in Massachusetts. The income of the trust was to be paid to petitioner for her life. Upon her death one-half the principal and any accrued income was to be paid over to Nancy Carroll Draper if living, to her issue per stirpes if she was then dead, or if no such issue were surviving, to Draper or his estate or as he should have appointed by will. The remaining one-half of the principal and accrued income was to be paid over to petitioner's estate or as she might have appointed by will. The trustees had the discretion to determine which of the receipts of the trust were principal and which were income. The trust was revocable by the joint action of petitioner and Draper, and, if so revoked, petitioner would receive all the corpus.

In 1934, 1935, and 1936 the Ruth Carroll Draper trust realized capital gains, all of which were added to principal.

The trustees of the Nancy Carroll Draper trust filed information returns for 1934, 1935, and 1936. For 1934 and 1935, three-quarters of the net trust income was shown as being distributable to petitioner as guardian for Nancy Carroll Draper, one-quarter of the income was shown as distributable to Draper, and capital gain or loss was treated by the trustees as not affecting distributable income. For 1936, one-third of the net income, less one-third of the capital loss, was shown as distributable to petitioner as guardian, and two-thirds of the net income, less two-thirds of the capital loss, as distributable to Draper for the account of Nancy Carroll Draper. In a rider attached to the return it was stated that the net income and capital loss were treated, under protest, as being accountable for by petitioner and Draper in proportion to their contributions to the corpus of the trust. Petitioner filed returns for 1934 and 1935 as guardian of Nancy Carroll Draper and reported three-fourths of the net trust income exclusive of capital gains as taxable to Nancy Carroll Draper.

The trustees of the Ruth Carroll Draper trust filed information returns for 1934, 1935, and 1936. For 1934 and 1935, those returns showed the entire net income, exclusive of capital gains, as being distributable to petitioner; and for 1936 the entire income of the trust, including capital gains, was shown, under protest, as being distributable to petitioner. The capital gains for 1934 and 1935 were shown as being retained by the trust. No part of the capital gains for 1934, 1935, and 1936 were ever paid over to petitioner.

OPINION.

LEECH: As regards the Nancy Carroll Draper trust, respondent argues that three-fourths of the net income, exclusive of capital gains, is taxable to petitioner on the ground that the trust discharged petitioner's duty to support her daughter, legal or contractual. Douglas v. Willcuts,296 U.S. 1">296 U.S. 1. He raises no issue as to the applicability of section 166, and it is noted that no such question could be successfully raised, since the power to revoke exists in petitioner only in conjunction with Draper, who holds a substantial adverse interest. See Paul W. Litchfield,39 B.T.A. 1017">39 B.T.A. 1017.

Respondent's contention that petitioner is under a duty to support her daughter rests first upon an invocation of the doctrine that the Commissioner's determination in this regard is presumptively correct. He says that petitioner's duty to her daughter is controlled by the laws of France and that he must prevail because petitioner has introduced no proof of French law.

The decree of the French court awarded custody of Nancy Carroll Draper to petitioner and left the matter of the child's support to the parties, refraining entirely from passing on the latter question. Thereafter petitioner and the child established a legal domicile in the State of New York, as was their right and privilege. Restatement of the Law of Conflicts of Law, sec. 32; 1 Beale, Conflicts of Law, 215; Toledo Traction Co. v. Cameron,137 Fed. 48. Draper, the ex-husband of petitioner and father of the child, returned to and retained his residence in Massachusetts.

Under the laws of New York, the duty of Draper to support the child survived the French divorce because the foreign court failed to pass upon the question and made no provision therefor in its decree. Laumeier v. Laumeier,237 N.Y. 357">237 N.Y. 357; 143 N.E. 219">143 N.E. 219; Manice v. Randolph,221 App.Div. 570; 224 N.Y.S. 496">224 N.Y.S. 496.

Under the laws of Massachusetts, if suit were brought against Draper there and the child were then a resident of that state, the proper probate court could have compelled the father to support the child, regardless of what a foreign court might or might not have done in the premises, and even though the child remained in the custody of its mother. Mass. G.L. (Ter. ed.) ch. 208, § 29; Durfee v. Durfee,293 Mass. 472">293 Mass. 472; 200 N.E. 395">200 N.E. 395.

On the instant facts, moreover, the case of Yarborough v. Yarborough,290 U.S. 202">290 U.S. 202, which holds that the forum granting the divorce has sole jurisdiction over the question of support of children, does not require a holding that French law is controlling, since in the Yarborough case the court which granted the divorce provided for support in its decree, whereas here that was not done. See 50 Harvard Law Review 1197.

We conclude, therefore, that the question of petitioner's obligations to her child is not controlled by the laws of France, and that under either Massachusetts or New York law, Draper's duties to support the child remained. It follows that the trust discharged his legal obligation, but not petitioner's, since she had none, and that she, therefore, is not taxable on any of the income of the Nancy Carroll Draper trust. Commissioner v. Yeiser, 75 Fed.(2d) 956; Martin F. Tiernan, Trustee,37 B.T.A. 1048">37 B.T.A. 1048. See also Lolita S. Armour,41 B.T.A. 777">41 B.T.A. 777.

Respondent's further contention, that petitioner was under a contractual duty to support her daughter because Draper had given her money on the understanding it would be used for the benefit of the family and she had used part of it to create the trust, is untenable, for a father can not by contract rid himself of his duty to support his minor child. Helvering v. Leonard, 105 Fed.(2d) 900; reversed on other grounds, 310 U.S. 80">310 U.S. 80.

The second issue is whether petitioner is taxable upon the capital gains realized in the taxable years by the Ruth Carroll Draper trust. These were not distributed to her but were added to principal.

It is true that under the law of Massachusetts, capital gains normally are to be credited to principal, rather than to income. Theodore R. Plunkett,41 B.T.A. 700">41 B.T.A. 700. But here the trustees were given discretion to determine which receipts were capital and which were income. Under section 167(a)(2) of the Revenue Acts of 1934 and 1936, a grantor of a trust is taxable on such of the income of a trust as may, in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income, be distributed to the grantor. A trustee is not a person having a substantial adverse interest within the meaning of the statute. Reinecke v. Smith,289 U.S. 172">289 U.S. 172; Sterling Morton,38 B.T.A. 1283">38 B.T.A. 1283; affd., 109 Fed.(2d) 47. There was, in consequence, nothing to prevent the trustees here from exercising their discretion and distributing the capital gains to petitioner. She is therefore taxable in respect of these capital gains under section 167(a)(2), supra. Malcolm W. Greenough,29 B.T.A. 315">29 B.T.A. 315; affd., 74 Fed.(2d) 25.

In view of this conclusion, it will not be necessary to pass on respondent's remaining contentions.

We find that petitioners overpaid their 1936 tax to the extent it was imposed in respect of one-third of the ordinary income of the Nancy Carroll Draper trust.

Decision will be entered under Rule 50.